New Law Undermines Diversification of Pension Assets

February 19, 2002

As financial advisers have been reminding everyone in the wake of Enron, the best 401(k) pension plan is one with a diversified portfolio. But on January 1, a new law took effect giving a tax break to corporations that match their employees' 401(k) savings with company stock rather than cash. That is not the road to diversification, analysts believe.

The Investment Company Institute reports that 19 percent of 401(k) assets are now in company stock.

At large companies the share is 25 percent.

At some -- including Proctor & Gamble and, before its stock collapsed, Enron -- the number has exceeded 50 percent.

Considering that many financial advisers counsel clients not to have more than 5 or 10 percent of their portfolio holdings in any one stock, many investors are far from the goal of prudent diversification.

The consulting firm Hewitt Associates finds that employees in 401(k) plans have an average of about 30 percent of their assets in their company's stock. Proof of the advantages of diversification comes from the research firm Morningstar Inc. It reports that since the beginning of 2000, nearly one out of every five U.S. stocks has fallen by two-thirds or more -- but only 1 percent of diversified mutual funds have swooned as much.

Sources: David Leonhardt, "Sweetening Pensions at a Cost to Workers," New York Times, February 17, 2002; and Aaron Lucchetti and Theo Francis, "Dangers of Not Diversifying Hit Investors," Wall Street Journal, February 15, 2002.